5.6 Production planning

Production planning

• Management process of ensuring sufficient inputs are available to create outputs

• In a timely manner to meet customer needs

Supply chain

• Diff stages of activities from production of product → distribution to end customer

• Network of the individuals, firms, resources, business operations, technologies involved in the creation and sale of a particular good

Supply chain management

• The art of managing + controlling the sequence of activities from the production of a product to delivery to final customer.

• Must be efficient + effective → firm can be profitable

• Work w suppliers to maximise efficiency

Local supply chain

• Short distances betw producers, suppliers, consumers

• In a confined location eg same city

• Efficient: less time, transport → good for environment, less prone to distruption

• Shorter supply chain

Global supply chain

• Long distance (spans multiple countries) betw firm, supplier, consumers

• Transactions on international level (eg trade)

• Cost effective (offshore production)

• Bad impact on environment, less sustainable

What do MNCs rely on to increase customer base + profits?

Global supply chain

Why is a long supply chain / ineffective SCM expensive?

Increases chance of:

1. Miscommunication

2. Late deliveries

So reshoring has become popular (less risk of long supply chain)

Main parts of SCM

1. Stock control

2. Quality control

3. Supplier networks- eg intermediaries

4. Transport networks

Pros of using SCM

1. Prevents mistakes that occur in long supply chains

2. Helps w stock control (prevents stockpiling → too much liquidity tied, or insufficient stock → delays)

3. Helps achieve lean production

4. Global supply chain → spread risks (eg if natural disaster in 1 country)

5. Global SC → easier for firms to sell around the world

Cons of using SCM

1. GSC: time, lang, cultural differences → miscommunication + delay

2. GSC: greater interdependence → single problem causes major issues (increased chance in GSC)

3. Need more time + resources

Just-in-time (JIT)

• Lean method of stock control

• Inputs scheduled to arrive precisely when they are needed in the production process

Features of JIT

• No need to hold buffer stock → less storage, insurance costs

• Improves firms working capital- money not tied up in inventory (illiquid)

Pros of JIT

1. No need to hold buffer stock → minimises storage costs

2. Form of lean production: less wastage → no inventory to expire / damage

3. Improves liquidity position- cash not tied up w inventory → improves cash flow

4. Lower stock management costs + improved quality → improves firms competitiveness

5. Reduces firms break even

6. Strengthens rs w suppliers → reduces lead time

Cons of JIT

1. Small orders → no EOS

2. Inflexible → can’t cater for sudden increase in demand → loss of sales

3. Heavy reliance on tech (for efficient stock control) → risk of tech breakdown

4. Heavy dependance on 3rd party suppliers

5. Suppliers charge higher prices for urgent stock delivery

Buffer stock

• The min stock level held by a business at any time

• Held as a contingency in case of unexpected orders for the firm's output OR delays from suppliers of RM / components / finished goods

Just in case (JIC)

• Stock control system

• Requires businesses to have large quantities of stock

• In case needed for an unexpected order / problem w the supply chain

• Aka supply or demand fluctuations

Does JIC use buffer stock?

Yes

• To meet changing demand

• Can meet unexpected orders quickly

What firms is JIC appropriate for?

Use durable stocks

• Not perishable

Pros of JIC

1. Uses buffer stock → flexible → can meet increase in demand → increase sales

2. Uses buffer stock → can continue production even if suppliers deliver stock late

3. Purchase large stock quantities → purchasing EOS

4. Maintains customer satisfaction

5. Less down time → less waste

Cons of JIC stock control

1. Increases costs- storage, maintenance

2. Stocks subject to damage

3. Not suitable for perishable products

4. Stockpiling reduces firms working capital + cash flow (esp if illiquid)

5. Opp cost of buing stock

JIT vs JIC

Stocks / inventories

• The goods that a business has available for sale, per time period

• Materials, components used in production process

• Intend to be sold ASAP, to generate cash for  the business. 

3 types of stock

1. Raw material (natural resources)

2. Semi-finished goods / work in progress (incomplete)

3. Finished goods (complete, ready to sell)

Why is managing stock importance?

To avoid:

• Stockpiling

• Stock-outs

Stockpiling

• Business orders + hold more stock than it would usually do (too much)

• Bc anticipating high levels of demand

Stock-outs

When a business has no more stock for production or sale

Cons of stockpiling

1. Storage costs

2. Stock can perish / damage

3. Semi-finished goods = v illiquid

4. Changing tastes → no demand for stock → becomes obsolete → high discounts to sell (low PM)

Cons of stock-outs

1. Lose sales (to rivals) → less revenue

2. Production halted → inefficiencies + delays

3. Poor corporate image → harms customer loyalty

Stock control charts

• Visual tool used to monitor + analyse a firm’s stock levels

• Shows rate which stocks are used, when stocks are order, how long they take to be distributed, and when they are delivered. 

Main features on stock control charts

1. Lead time

2. Buffer stock

3. Re-order level

4. Re-order quantity

Maximum stock level

• The most amt (upper limit) of stock that a firm wants to hold at any point in time

• Based on its storage facilities + capacity

Buffer stock (min stock level)

• The lowest amt (lower limit) of stock that a firm wants to hold at any point in time

• Due to precautionary measures eg unexpected demand

• The more efficient a firm is → lower BS

Reorder level

• The level of inventory at which a firm places a new order for stock

• Helps prevent production problems due to lack of stock (due to lead time)

Reorder quantity

The amount of new stock that is ordered for production

• Max - min stock level on stock control chart

How to determine reorder quantity?

Max - min stock level

Lead time

• The duration (time lag) betw a firm placing an order for stock + receiving delivery of the stock

If a firm has high lead times, will it hold high or low buffer stocks?

High

• Longer lead time → higher buffer stock

Usage rate

• Shows the speed (rate) at which stocks are used in the production process

• On stock control chart

• Higher UR = more freq reorder

Usage rate formula

Usage rate per time period = Stocks used / Time period

Draw a stock control chart

When do usage rates tend to increase + decrease?

• Increase- economic prosperity + peak-periods

• Decrease- recession, off peak

What happens if firms have longer lead times?

1. Need to reorder earlier

2. Or need to reorder larger amounts

Why can low buffer stock levels be held w short lead times?

• Producer knows new stock orders will be delivered soon → prevents delays to production

Cons of stock control charts

Simplistic

• Affected by late deliveries, seasonal fluctuations in demand, production delays

Factors influencing amt of stock a business holds

1. Type of product

• Fast moving- high (due to high stock turnover)

• Perishables- low (prevent spoilage)

• Consumer durables- low (purchased infrequently)

2. Expected demand level

• High demand- high

3. Lead times

• Long- high

4. Cost of holding stock

• High OC of stockpiling (eg jewelry)- low (risk of damage / theft)

• Low OC- high (eg fast moving, low cost goods)

Capacity utilization

• The extent to which an organization operates at its maximum level (productive capacity)

Capacity utilization rate

Measures a firm’s actual output as a % of its capacity (maximum potential output), at a particular point in time. 

• Measure of efficiency

Productive capacity

The max level that a firm is able to operate at, given the resources it has

• All resources are used fully + efficiently

Capacity utilization rate formula

(actual output / productive capacity) x 100

What does it mean if a firm has 0% capacity utilization?

Not producing any output

When is capacity utilization likely to fall?

1. Demand level falls

2. Insufficient resources

Pros of HIGH capacity utilization

1. Helps achieve EOS (high CU = increase output = EOS, AC fall)

2. Helps reduce AC → more competitive

3. Lower AC → increase profits

4. Means firm is productively efficient

5. Reach BEP faster

Cons of HIGH capacity utilisation

1. Employees become overworked → stressed + demotivated

2. Machinery wears out + depreciates faster → higher maintenance + replacement costs

3. Focus on quantity of output → quality suffers → reduced customer satisfaction

4. Need to upgrade IT systems- expensive

5. Doesn’t lead to growth- need to increase productive capacity for this

Zero defects

An aspect of lean production that focuses on preventing mistakes being made by getting things done right, first time round.

Defect

• Output that is substandard

• Needs to be re-produced- wastes time, money, resources

Defect rate

• Measures proportion of output that is substandard, per time period

Defect rate formula

1. (defect output / total output) x 100

2. (defect output / no. output tested) x 100

Higher defect rate…

Lower quality of output

Cons of high defect rate

1. Poor rep → less sales, hard to attract customers

2. Rework → increases costs

3. Waste- time, material, labor → harms liquidity position

4. Wastes money- opp cost- could have been used for marketing / innovation

5. Legal issues → lawsuits (eg if defect harms customer)

6. Customer dissatisfaction → complain → negative word of mouth (more powerful than ATL)

Productivity

• The level of efficiency in the production process

• The more productive  resources are, the more output they generate.

3 ways to measure productivity

1. Labor productivity

2. Capital productivity

3. Operating leverage

Productivity rate formula

Productivity rate = (Total output ÷ Total input) × 100

Productivity rate = (Total output ÷ Total input)

Labour productivity

Measures the average level of output per worker, for a given period of time

• Efficiency of labour

Labour productivity formula

Labour productivity = Total output ÷ No. of workers

Capital productivity

Measures how efficiently an organization’s fixed assets are used  to generate output for the business. 

Capital productivity formula

Capital productivity = (Total output ÷ Total capital input) × 100

Capital productivity (output per machine hour) = Total output ÷ Machine hours

Pros of high productivity rates (4 Es)

1. EOS (reduce AC → low price for customers / greater PM)

2. Earnings (high profit → can reinvest, OR → pay workers higher wages → easier to attract high skilled employees)

3. Efficiency → increases competitiveness

4. Evolution aka growth → increase productive capacity

What determines productivity rates TRIES (not in spec)

1. Tech- new tech → increase productivity

2. Rivalry- comp → incentive to be productive (low price to consumers)

3. Innovation- can increase labor productivity (eg offline work)

4. Entrepreneurship

5. Skills / experience- improved quantity + quality of labor → increase productivity

Operating leverage

• Financial ratio

• Measures how a firm's operating income is affected by its fixed costs, variable costs, and sales

• FC as proportion of VC

Shows extent to which firm can increase operating income by increasing SR

If a firm has relatively high fixed costs, will they have a high or low operating leverage?

High OL

Operating income / profit

Firm's earnings from SR before interest and taxes are deducted

• Operating income = Gross profit − Operating expenses

Operating leverage formula

OL = total contribution / net profit

OL = ((P- VC) x Q) / ((P-VC)xQ - FC))

Why is a high operating leverage bad?

• Increases BEP

• Sales drop → can’t cover fixed costs

Is it bad if firms have high VC?

No

• BC if SR drops → VC drops

High operating leverage =

Higher risk BUT higher profit potential

What does it mean if a firms OL is less than 1?

1. Making loss on product

2. Costs more to produce than earns in profit

3. Next steps: reassess pricing methods / increase efficiency

If a firm has low OL bc most of its production costs are VC, what should it do? (kinda imp?)

• Consider automation

• But automation → higher fixed costs, lower variable costs

• But its fince bc if demand increases → costs increase less (bc lower VC), so profits increase more

What does it mean in terms of FC and VC if a firm has a low OL?

• FC relatively low compared to VC

• Low FC, high VC

• Sales falls → VC fall → easier to earn profit at low sales level (low risk)

• But needs high sales vol to earn profit

Make or buy decision

• The choice managers / firms have whether to manufacture a product in-house or to purchase it from a third-party subcontractor

• Based on CTM and CTB

Cost to buy

• Calculates the total cost of subcontracting production to a third-party supplier

• In MOB decision

Cost to make

• Calculates the total cost of  producing the product in-house, instead of using a third-party provider

• In MOB decision

Cost to buy formula

P x Q

Cost to make formula

(AVC x Q) + TFC

When will a firm make vs buy? (based on quantitative reasoning only?)

• CTM > CTB: buy (outsourcing or subcontracting)

• CTB > CTM: make (insourcing- in-house production)

Qualitative factors to consider in make or buy decisions

1. Product quality- buy vs make

2. Timeframe

3. Availability of spare capacity to meet extra orders

4. Reliability of suppliers- to deliver on time

5. Decision is irreversible (contract terms and conditions)